After the brief “correction” in October, the market basically pulled a Men In Black where it essentially looked at the pen and proceeded to forget the past and resumed its ascendency to record highs. I made a couple of moves on my portfolios to bank some profits and to open some new positions. This is despite my feelings that the stock market is still overpriced.

I really believe investing is more of an art than a science. The science part (analyzing financial statements and ratios, calculating Net Present Values, evaluating an investment opportunity) is repetitive and intuitively simple, especially as you practice more and more of it. The truly hard part is acting upon that analysis to make that decision because unfortunately, life and the world get in the way and can force us to make a decision that may not be in our best interest. Emotions, ego, and greed always can get the best of us and it is a constant struggle for investors of all stripes and experience. I have been investing since 1996 and even after analyzing thousands of companies and stocks, and knowing the pitfalls of investing, I still will face decisions that challenge what I have learned and applied in the past. Whether it is value investing, technical analysis, or day-trading, we will always face situations that will challenge our decision making ideology. I would like to share with you one classic example I am currently facing. It involves the dilemma of selling stocks.

Since the start of 2013, I have been quite skeptical about the stock market as a whole. Many indicators both technical and sentiment-based have shown a high level of exuberance for stocks (My Consensus Watch Blog structures them appropriately). It has also been driven primarily by Central Banks around the world printing money, lowering interest rates to practically nothing in order to “guide” people to own stocks despite economic fundamentals that have been mediocre at best as well as major economies facing fiscal restraints. At this point it appears to me that asset prices are distorted. When companies like Best Buy who have a challenged business model, proceed to double in value, I have to wonder. To me it just seems unsustainable for the markets to continue on this upward trend as long as this disconnect between company fundamentals and stock prices remains. Within this context, I built a position in shorting the S&P 500 index. That being said, I have not stopped buying stocks. I have been just more selective in buying solid brands that are creating tangible Economic Profit and are still trading at discount.

So far it has been a bad investment decision. As of this writing, I am down 19 percent (fortunately owning some individual stocks have more or less offset this loss). One of rules I practice and instill in others in my coaching work is to establish a maximum loss I am willing to take on an investment. It is driven primarily by one’s own risk tolerance. For me it is 20 percent. When a stock is down 20%, I will usually sell and take the loss. The big reason for capping losses is that the lower it goes the higher the stock must return just to break-even. For example, a 20% loss requires a 25% return to break even. A 50 percent loss requires a stock to double to break even, which is extremely hard.

So if I were to remain true to my strategy, I should just simply sell my short position, admit my mistake, call it a day and move on. Easy enough? Here is where life gets in the way or in this case market/economic fundamentals. To me the story has not changed. Market sentiment continues to remain exuberant. Investors are showing no respect for the concept of risk and are willing to leverage themselves to gain yield. Companies themselves are pigging out on debt to max out their valuations. It is at these points where I have observed it is a good time to take the other side of the trade. Historically it is at these moments where stock markets splash cold water on the party. The Central Banks are at some point going to pull the punch bowl and start taking money out of the system and that will end the party. The problem is we really donâ€™t know when that could happen. It could happen in 2014 or 2015 but that is a long way away. The market could easily keep going up and my losses would be higher. To me a Game Changer moment is in the offing so I am challenging my 20 percent loss rule and wondering if I should continue to hold my short position if the market continues to go higher. If it keeps going higher, it will become harder to make my money back. Here enters the dilemma.

If investing is truly a science then I should sell but emotion has a funny way of screwing us over as investors. This is where investing becomes an art. Despite one’s experience and literacy, sometimes we will be faced with decisions that will challenge our knowledge base and value system and force us to go in another direction. I guess this is what they call a “gut” feeling? In my case, my gut is telling me this cannot continue.

I suspect many of you have been in a similar situation. We have all owned that stock (Nortel, RIM come to mind) that has gone in to the toilet but we still believe there is hope and it will turnaround. We want to believe and will it back to health. Unfortunately, they do not teach this to you in text books or call-in investment shows because these types of decision are very personalized and driven by your values, your tolerance for risk and your emotions. They are very good at teaching you the science of investing but not the art.

I guess what makes this particular decision harder is that I am investing in the broader market instead of a specific company so external pressures a company faces is more localized than a broad basket of companies. If a company reports bad earnings or is under competitive threat or committing accounting fraud the decisions are much clearer.

So what did I decide to do? Like any decision it is a tug of war. One day I have been thinking just sell it all and another day I through I should hold on a little while longer while on other days I go down the middle and think I should sell half the position . All kinds of emotions go through as you do not want to make the wrong decision. Finally I decided to go down the path of experience and to take a long term approach. In the long-term, this rally is unsustainable. Interest rates are going to go up. There will be a pull-back. Right now it looks like it will be a while away. I know I cannot time the market so I may be early to the game, but I do not want to miss out when things finally crap out. I realize holding on the short position is going to be ugly in the short-term, but to make it less painful, I could continue to offset the position by adding to my long positions in individual stocks. In terms of the total portfolio, the short position represents about 12% of my equity position and about 5 percent of the total portfolio, so this is not going to break things up. What this means is I will have to be diligent and ready to adjust when the pendulum shifts because it could be a violent one. I decided to bite the bullet and hold on.

As you can see, this was not an easy decision even with my experience. Imagine how one who had very little exposure to investing would face this type of decision? It is very common to expect our investing ideology to clash with the realities of the stock market and the economy. In some cases we will check our egos at the door and bite the bullet and in other cases our ego and “gut” will win out. In my case, my experience is telling me that you do not “Fight the Fed” but my ego is saying I can beat them. Let’s see what happens. I will update this article as time goes on.

UPDATE: July 11, 2013Today the markets surged upward on recent comments by the Fed Chairman, Ben Bernanke. Mr. Bernanke clarified the Fed position stating that the central bank will not begin to reduce purchases of bond (i.e. print money) until the economy is strong enough. Essentially this means the trend for stocks is to resume its upward ascent, economic fundamentals be damned. The recent comments indicate that it is likely we will not see any movement on interest rates until 2014. So the hysteria continues. Within this context, I decided to pare back my short position in the S&P 500 by half. There is just no sense fighting the Fed now, eventhough the diagnostics look crappy. I decided to keep a smaller short position because at some point, the tides will turn.